Technical Annex

Box 9: Summary of Technical Annex

This Technical Annex sets out new economic modelling quantifying
the potential effect of a Brexit driven reduction in migration on
both the
UK and Scotland
economies, and the relative importance of such a reduction in
migration to Scotland's economy compared to the rest of the
UK.
[16]

Assumptions on extent of reduction in migration:
In order to estimate the economic impact, it is necessary first to
consider what the level of migration could be if recent migration
trends continued and then second to consider what the level of
migration could be after Brexit.

Historic trends show variability in net overseas migration but
in 2016 the figure was 22,900.

There are a number of alternative projections for net overseas
migration in future years. We take the high migration variant
migration projection to represent the level of migration if recent
migration trends continued. The level of net long-term
international migration in Scotland associated with this projection
is 15,500 per year. (It should be noted that this is below the
levels seen in recent years.)

We then take the principal projection to represent the level of
migration in the event of Brexit. Net long-term international
migration in Scotland associated with this projection is 7,000 per
year.

The difference between these two projections –
approximately 8,500 per year – is what we take as the
Brexit-driven reduction in migration.

Given the uncertainty over such an outcome, other projections
are also possible and this is discussed in the sensitivity
analysis. The approach for the rest of the
UK adopts the same
assumptions, that is, uses the difference between the
ONS high
migration variant and the principal projection to represent the
level of Brexit-driven reduction in migration.

Model: A dynamic computable general equilibrium
model (
CGE) of
the Scottish economy and the rest of the
UK economy was used to
examine the net additional economic impact by modelling a decrease
in labour supply (a reduction in the working age population).

Findings: Our modelling estimates that real
GDP in Scotland
will be 4.5% lower by 2040 than it would have been otherwise, as a
result of the Brexit-driven reduction in migration. This is
equivalent to a fall of almost £5 billion per year in
GDP by 2040.

The impact across the rest of the
UK is found to be
smaller. Real
GDP in the rest
of the
UK could be 3.7%
(£47.5 billion) lower by 2040 as a result of the
Brexit-driven reduction in migration.

Scotland experiences a proportionally larger negative impact
relative to the rest of the
UK. This is because
Scotland relies more heavily on migration to grow its working age
population than the rest of the
UK, which enjoys higher
levels of natural population growth. The proportionately larger
impact on Scotland is equivalent to £1.2 billion per year by
2040.

Implications: The modelling confirms that Scotland
will suffer a proportionately larger negative economic impact as a
result of the Brexit-driven reduction in migration. This is because
of the different demographic profile of Scotland compared to the
rest of the
UK.

Further modelling set out in this Technical Annex shows that if
a different approach to migration policy in Scotland leads to
higher levels of migration then a growing labour force could boost
the economy.

This Technical Annex also provides an overview of the key
literature on the impact of migration on the economy. It then
builds on the findings from the literature review to set out new
economic modelling showing how lower migration as result of Brexit
will impact on the Scottish economy and the rest of the
UK respectively.

Overview of literature on the contribution of migration to
economic growth: Productivity, skills, and innovation

Most of the economic literature on migration finds that,
overall, migrant workers have a positive effect on the host country
and can contribute to higher economic growth.

This growth can be achieved through incoming migrants providing
a boost to the labour supply, thereby expanding the productive
capacity of the economy, resulting in higher levels of economic
activity and employment, making the economy as a whole more
competitive. As well as adding to the supply side of the economy
(expansion in the labour force), migrants also contribute to
increased demand for goods and services in the economy (as migrants
are also consumers).

Recent Scottish Government modelling undertaken for the response
to the
MAC looked
at the economic contribution of
EU citizens to the
Scottish economy. This work found that on average, each additional
EU citizen working in
Scotland contributes a further £34,400 in
GDP. As there are
approximately 128,400
EU citizens employed in
Scotland, this analysis implies that the total contribution of
EU citizens working in
Scotland is approximately £4.42 billion per year. Migrants
also make a contribution to tax revenues – the modelling
shows that each additional
EU citizen working in
Scotland contributes £10,400 in government revenue.

A review of the wider economic literature suggests that migrants
who move for economic reasons are likely to pay more in taxes than
they receive in benefits.
[17] This means that the host country receives a fiscal
contribution from their employment.

There is also evidence that these workers can also have a
dynamic effect in helping to improve productivity
. Migrant workers bring new skills and expertise into the
country, they provide additional resources to help ensure that
businesses can manage skills and staffing shortages, and typically
have high levels of entrepreneurship which helps lay the
foundations for future economic growth.
[18]

There are a number of sources outlining the positive economic
benefits of skilled migrants. For example, a summary of the
available evidence by the Bank of England suggests that
EU workers may have
filled skill gaps or specialised in different tasks. Specifically
at the firm level, the Bank points to research by Rolfe et al
(2013)
[19] that found that employers in the pharmaceuticals,
IT, banking and
universities sectors recruited from outside the
UK in order to fill
skills gaps that exist in the resident population, and to
complement the skills of non-migrants.

Work by Ortega and Peri (2014) finds evidence that migration
boosts long term
GDP per capita,
through increased diversity of skills and through higher innovation
activity.
[20] In-migration is found to have both direct effects on company
productivity as well as indirect impacts by raising the
productivity of the native human capital through transfer of
know-how.

This study also provides evidence that as well as the direct
boost to productivity; the resident population may also gain via
any indirect effects of skilled immigration on productivity. These
positive benefits may arise through enhanced specialisation of
procedures, job creation in complementary tasks, and wider dynamic
effects on the labour market

More recent work by Ottovanio et al (2016)
[21] finds a productivity and general export promotion effect of
immigrants. The study also finds that immigrants promote bilateral
exports across service industries to their countries of origin,
with an economic magnitude near the upper range of estimates found
with respect to goods trade.

Furthermore, available evidence
[22] has suggested that migration does not appear to have had a
statistically significant impact on the average wages and
employment opportunities of the
UK-born population in
periods when the economy is strong, although there is some evidence
of labour market displacement when the economy is in recession.

The available evidence for the
UK indicates that any
adverse wage effects of migration are likely to be greatest for
resident workers who are themselves migrants. Evidence also
suggests that displacement effects dissipate over time, as the
labour market adjusts.

Modelling the economic impact of lower working age population
on the economies of Scotland and the rest of the
UK

Economic modelling

The economic modelling uses a macroeconomic model of the
Scottish and the rest of the
UK economy. The type of
model used is known as a dynamic computable general equilibrium (
CGE)
model.
CGE
models take account of the inter-dependencies between different
sectors, agents (private sector, government and households) and
markets in the economy.

We use the Scottish Government's own
CGE
model, which has itself previously been used to model a range of
economic policies, with variations of the model used in similar
studies by academic institutions.
[23] A description of the model can be found on the Scottish
Government website.
[24]

Our framework models Scotland and the rest of the
UK simultaneously. This
is vital as Scotland and the rest of the
UK experience different
demographic projections and any economic spill-over effect from
Scotland into the rest of the
UK and vice versa is
captured within the model. Additional details of the model and the
underlying assumptions are presented in a technical addendum at the
end of the Annex.

Lower migration leads to a reduction in the working age
population which in turn contracts the supply-side capacity of the
economy. As this is a permanent shift, the economy converges to a
new equilibrium, characterised by a lower level of economic
activity and employment. The reduction in labour capacity allows
wages and prices to adjust in such a way that the economy as a
whole becomes less competitive, causing exports to fall.

The negative impact on the economy leads to lower household
consumption, investment and real
GDP. Given that
Scotland relies more heavily on migration to grow its working age
population than the rest of the
UK, Scotland experiences
a greater negative impact on all these economic variables than the
rest of the
UK.

Assumptions on extent of reduction in migration

As set out in the main paper, Scotland has a markedly different
demographic profile both in terms of trends and also in terms of
projections.

In order to estimate the economic impact, it is necessary first
to consider what the level of migration could be if recent
migration trends continued; and then to consider the level of
migration after the
UK leaves the
EU. This is done as
follows:

Historic trends show variability in net overseas migration
but in 2016 the figure was 22,900.

There are a number of alternative projections for net
overseas migration in future years
[25] and the chart below summarises these.

We take the
NRS
overseas migration projection known as the 'high migration
projection' to represent the level of migration if recent
migration trends continued. The long-term level of migration
associated with this projection is 15,500 a year. It should be
noted that the level of net overseas migration associated with
this projection is below the levels seen in recent years. For
example, the 15,500 is a 32% reduction from the levels of
overseas net migration to Scotland reached in 2016. Similarly, it
is well below the increase of 32,000 a year in working age
population which Scotland would need to maintain dependency ratio
at its current level.

We then take the
NRS
overseas migration projection, known as the 'principal
projection' to represent the level of migration in the event of
Brexit. The long-term level of migration associated with this
projection is 7,000 a year.

The difference between these two projections –
approximately 8,500 a year for Scotland and 72,000 a year for the
rest of the
UK – is the level
of Brexit driven reduction in migration

Given the uncertainty over such an outcome, other projections
are also possible. This is analysed in the sensitivity
analysis.

The approach for the rest of the
UK adopts the same
assumptions, that is, uses the difference between the
ONS
'high projection' and the 'principal projection' to represent the
level of Brexit-driven reduction in migration.

The Brexit driven reduction in migration is then simulated
through the economic model and the size of the shocks are estimated
by calculating the percentage change in working age population
between the two projections.

In our simulation, we model changes in the number of people of
working age from 2018 to 2040. As highlighted in the table below,
Scotland experiences a larger decrease in working age population
than the rest of the
UK.

Table 4.1: Change in working age population for Scotland
and the rest of
UK

2018

2022

2027

2032

2037

2040

Scotland

-11,000

-40,000

-77,000

-115,000

-156,000

-183,000

rest of the
UK

-93,000

-344,000

-660,000

-980,000

-1,316,000

-1,533,000

Key findings

The key findings of this analysis measuring the impact of a
Brexit driven reduction in migration are presented below.

Our modelling estimates that real
GDP in Scotland
will be 4.5% lower by 2040 than it would have been otherwise, as
a result of Brexit-driven reduction in migration. This is
equivalent to a fall of almost £5 billion a year in
GDP by
2040.

The impact across the rest of the
UK is found to be
smaller. Real
GDP in the rest
of the
UK could be 3.7%
(£47.5 billion) lower by 2040 as a result of Brexit-driven
reduction in migration.

The Brexit driven reduction in migration produces negative
impacts on Scottish
GDP which are
proportionately greater than for the rest of the
UK. The larger economic
cost faced by Scotland is equivalent to £1.2 billion a year
by 2040.

Therefore a Brexit driven reduction in migration represents a
specific risk to Scotland and suggests that a
UK-wide migration
policy may not fit Scottish economic needs.

Figure 4.2 shows the economic impact of lower working age
population in Scotland and the rest of the
UK as a result of the
Brexit driven reduction in migration.

Figure 4.2: Change in real
GDP, Scotland and
rest of the
UK from lower working age
population

This decrease in the working age population would also have a
proportionately larger impact on tax revenue raised in Scotland
than in the rest of the
UK. The analysis shows
that the reduction in revenue would be 3.5% (£1.5 billion) in
Scotland compared to 2.7% (£12 billion) in the rest of the
UK by 2040.

Sensitivity analysis: alternative assumptions on the extent of
reduction in migration

As noted above, there are alternative projections for overseas
migration. We therefore undertake sensitivity analysis to explore
the economic impact of these alternative projections on the
Scottish and
rUK economies.

The two sensitivity analyses we explore are based on the '50%
EU migration projection'
[26] and the 'low migration projection'.
[27] These replace the 'principal projection' in the base case
analysis. That is to say, the first sensitivity analysis models the
difference between the 'high migration projection' and the '50%
EU migration' projection
and the second sensitivity analysis models the difference between
the 'high migration projection 'and the 'low migration projection'.
These differences represent the reduction in migration from Brexit
and as such both these sensitivity analyses result in even lower
levels of migration than under the base case analysis.

The 50%
EU migration projection
assumes that
EU migration will
decrease by half from 2018 onwards reaching a long-term level of
4,300 a year. The difference in net overseas migration between the
high migration and the 50%
EU migration projection
is approximately 11,200 a year. This outcome may occur if migration
from the
EU to the
UK falls substantially as
a result of Brexit. The Scottish Fiscal Commission made the
judgment to use the demographic variant of 50% reduction in
EU migration for the
purpose of producing five year economic and fiscal forecast for
Scotland.
[28] In the report accompanying its forecast the Scottish Fiscal
Commission stated
"given the potential impact of changes in the
UK's relationship with
the
EU, the Commission's
judgement is that a lower migration assumption is more appropriate.
Therefore the Commission uses the
ONS 50%
EU migration variant
projection".

The low migration projection assumes that overseas migration to
the
UK will fall and reach
85,000 a year by 2022. This is consistent with the
UK Government target to
reduce net migration to the tens of thousands. Under this scenario,
Scotland is projected to experience negative long-term overseas
migration equal to 1,500 migrants a year. This means 1,500 more
people a year would leave Scotland than arrive from overseas. The
difference in net overseas migration between the high and the low
migration is close to 17,000 a year.

The economic impact of lower migration is presented in table
4.2.

Table 4.2: Impact on Scottish and rest of the
UK (
rUK) real
GDP of lower
migration relative to the high migration projection

2020

2030

2040

Scotland

rUK

Scotland

rUK

Scotland

rUK

Base case
'Principal projection'

-0.4%

-0.4%

-2.3%

-2.0%

-4.5%

-3.7%

'50% reduction
EU migration'
projection

-0.6%

-0.5%

-3.1%

-3.0%

-6.2%

-5.9%

'Low migration projection'

-0.9%

-0.8%

-4.7%

-4.0%

-9.3%

-7.6%

Under the 50% reduction in
EU migration scenario,
Scottish real
GDP is lower by
6.2% (£6.8bn) and '
rUK' real
GDP by 5.9%
(£75.4bn) than it would have been the case if Scotland and
the rest of the
UK followed a path of
high migration. This outcome presents a more pessimistic outcome on
both Scotland and the rest of the
UK than our original
analysis. In the worst case scenario of low migration, Scottish
real
GDP is lower by
9.3% (£10.2 billion) and the rest of the
UK real
GDP by 7.6%
(£96.3 billion).

The overall conclusion of this sensitivity analysis is that, the
more pessimistic the projections of working age population are, the
larger the negative impact on the economy of Scotland and the rest
of the
UK.

The economic boost to the Scottish economy if higher
levels of migration could be achieved

Further modelling is undertaken to demonstrate the economic
benefits that would flow if Scotland could achieve higher levels of
migration under three scenarios.

We simulate three scenarios based on a long-term annual increase
in net overseas migration of 5%
[29], 10%
[30] and 20%
[31] above the level of overseas migration assumed in the high
migration projections for Scotland. Under these three scenarios,
overseas net migration would reach 16,000, 17,000 and 19,000 a year
respectively. These levels of migration are still lower than the
net overseas migration of 22,900 reached in 2016. In addition, the
three scenarios are still below the increase of 32,000 a year in
working age population which Scotland would need to maintain its
dependency ratio at the current level. In our modelling, we assume
no change in the level of overseas migration to the rest of the
UK.

Increasing Scotland's working age population would have a
positive impact on the economy. Higher migration results in a
growing working age population which leads to more economic
activity and employment. The economic impact of pursuing these
demographic trajectories can be seen in the graph below.

Higher levels of overseas migration of 5%, 10% and 20% leads to
a long-term increase in real
GDP equal to 0.4%
(£0.5bn), 0.8% (£0.9bn) and 1.6% (£1.8bn).
Moreover the increase in economy activity has a positive impact on
real Government revenues which rise by 0.3% (£0.2bn), 0.7%
(£0.3bn), and 1.4% (£0.6bn) respectively. If Scotland
were to follow the path of net overseas migration set out in the
base case of 'principal projection' then the benefits of achieving
the level of higher migration of these three scenarios would be
even greater.

The conclusion is that if further migration powers could achieve
higher levels of migration into Scotland then our economic
modelling suggests that a growing labour force would have a
positive economic impact.

Figure 4.3: Impact of an increase in working age population
due to higher migration on Scottish
GDP

Conclusion

The economic literature suggests that migrant workers can fill
skill gaps, complement the skills of domestic workers and help
drive productivity improvements in the economy.

Migration can also help mitigate the demographic pressures
arising as a result of Scotland's aging population. Scotland has a
markedly different demographic profile from the rest of the
UK and migration has been
crucial in turning around Scotland's trend of population decline.
Migration will only be more important as our population continues
to age, particularly in boosting the working age population.

The vote to leave the European Union therefore adds an
additional headwind to Scotland's demographics. The economic impact
of Brexit driven reduction in migration is estimated to be equal to
a reduction in real
GDP of 4.5% in
Scotland and 3.7% in the rest of the
UK by 2040. Such a
reduction would also result in a decline in Government revenue of
3.5% in Scotland and by 2.7% in the rest of the
UK.

The sensitivity analysis also highlights that if the projection
followed the
UK net migrationtarget
GDP would have
been even lower. By 2040 real
GDP would fall by
9.3% in Scotland and 7.6% in the rest of the
UK.

The economic modelling shows that lower migration has
substantial negative consequences on both the Scottish and the rest
of the
UK economies. However,
given the considerable larger negative impact on Scotland's
economy, there is a strong economic case for additional immigration
powers in Scotland. This appears to be the best way to mitigate the
negative impact that demographic changes are likely to have on
Scotland's economy.

If further immigration powers could achieve higher levels of
migration into Scotland then our economic modelling suggests that a
growing labour force would have a positive economic impact. For
example, if overseas migration were to increase by 5%, 10% and 20%,
in 2040 real Scottish
GDP would rise by
0.4%, 0.8% and 1.6% respectively.

Table 4.3: Summary of the modelling results - Impact on
Scottish and rest of the
UK real
GDP of changes
in migration in 2040

Scotland

GDP (%)

Government Revenue (%)

GDP
(£)

Government Revenue (£)

Base case -

-4.5%

-3.5%

-£4.9 5bn

-£1.5bn

50%
EU

-6.2%

-4.7%

-£6.8bn

-£2bn

Low migration

-9.3%

-7.2%

-£10.2bn

-£3.1bn

20%

1.6%

1.4%

£1.8bn

£0.6bn

10%

0.8%

0.7%

£0.9bn

£0.3bn

5%

0.4%

0.3%

£0.5bn

£0.2bn

Rest of the
UK

GDP (%)

Government Revenue (%)

GDP
(£)

Government Revenue (£)

Base case -

-3.7%

-2.7%

-£47.5bn

-£12bn

50%
EU

-5.9%

-4.4%

-£75.4bn

-£21.8bn

Low migration

-7.6%

-5.6%

-£96.3bn

-£27.8bn

Modelling Assumptions

As with all economic models, a set of assumptions are made about
how the economy adjusts to the shock applied. The key assumptions
made are:

all labour is homogenous. This means new entrants in the
labour market work the same number of hours and have the same
productivity level and skill set as those already in the labour
force;

wage bargaining takes place, where real wages are a
decreasing function of unemployment levels; and

the Government aims to balance its fiscal balance. Any
fluctuations in government revenue will be reflected in changes
in government expenditure. As the tax base contracts, less can be
collected in revenue, reducing public sector expenditure. This is
consistent with the idea that any decrease in labour supply will
be seen as a permanent reduction of Government services such as
health and education. As a result the Government would adjust and
reduce its expenditure.

The Model

CGE
models
[32] are large-scale simultaneous equation models which combine
General Equilibrium theory with real economic data to derive
computationally the economic impact of policies or shocks. We model
the changes in demographics by shocking labour supply for 25 years
consecutively. We do not shock the model in any other respect, and
as such future policy changes are not modelled.

Figure 4.4: Diagram of
CGE
Modelling

Computable general equilibrium (
CGE)
models take into account the inter-dependencies between different
sectors, agents and markets in the economy. This allows analysis to
shed light on the wider economic impact of policies, revealing
combined direct and indirect effects of shocks.

The model is made up of numerous structural equations which
describe the behaviour of different agents in the economy, such as
households, firms and government. Households and firms aim to
maximize their objective functions subject to some constraints,
whilst government aims to maintain the chosen fiscal closure.

In absence of any economic shocks, the model is in steady state
equilibrium. In this equilibrium, demand equals supply in every
market and markets clear. After an economic shock, the economy
falls out of equilibrium and imbalances occur across the economy.
As a result of market clearing conditions, all markets adjust
across time until a new equilibrium is achieved. Unlike many
CGE
models, the Scottish Government
CGE
model accounts for non-market clearing of the labour market,
allowing for unemployment in the model.

The dataset which forms the backbone of the
CGE
model is the Social Accounting Matrix (
SAM). It
captures the flows of all economic transactions which take place in
the economy in a single year. Its primary data sources are the
Input-Output tables and the national accounts, complemented by a
range of other data on tax, income and expenditure.

In the Two-Region Scottish Government
CGE
Model, the
rUK economy is treated as
endogenous to the Scottish economy. This difference from the
Single-Region
CGE
model allows for economic shocks to reverberate across the entire
UK economy, reflecting
the interdependencies that exist between the Scottish and
rUK economies. This model
is calibrated using a
SAM for
Scotland, and a
SAM for
rUK. Shocks can be
imposed on either the Scottish or
rUK economy
independently, or combined.